Auditor Liability Caps, PCAOB Enforcement, IFRS, More

Accounting ethics professionals are still open for comments through Dec. 15 on their proposed guidance for how auditors should seek liability protections in private company audits without compromising their independence.

The Professional Ethics Executive Committee of the American Institute of Certified Public Accountants will meet in late January to finalize the guidance, said Lisa

A. Snyder, director of AICPA’s professional ethics division.

The guidance says auditors would impair their independence if they seek to limit or eliminate liability from their own or their client’s negligence, but not when problems arise from a client’s fraudulent behavior. That’s different than the threshold set by the Securities and Exchange Commission, which says auditors lose their objectivity if they are protected even from a client’s misrepresentation.

Snyder said the committee decided to study the issue when banking regulators earlier this year issued a proposal to warn financial institutions to reject auditors’ efforts to include them in their engagement letters. The AICPA believes auditor liability protections are appropriate in private company audits where fraud is exposed because private companies don’t have the same control environment, especially following Sarbanes-Oxley, to protect auditors.

The AICPA guidance is offered “strictly from an ethics and independence standpoint,” Snyder said, whereas for banking regulators, “their perspective is safety and soundness of financial institutions.”

Turley

Concerns about auditor liability often are associated with the viability of the accounting profession as a private industry and the level of competition among major firms. In a recent speech to the U.S. Chamber of Commerce, James S. Turley, chairman and CEO of Ernst & Young, reiterated what he told a Senate Banking Committee last year—that accounting firms face significant financial risks from litigation and that “good auditing is too often not a sufficient defense against the filing of legal claims.”

“The prospect of losing another major accounting firm—and the negative spiraling effect that would occur across the other firms and in our financial markets—must be recognized as a global economic concern,” Turley said.

Turley said the European Commission is further ahead in examining “what might be appropriate and necessary to sustain private-sector auditing,” referring to a 20-member forum that is studying a ceiling on auditor liability exposure and plans to issue a report next year.

“We in the profession understand and accept that there are legal liability risks inherent in the public accounting business,” Turley said. “It goes with the territory. The debate properly lies around the risk of an event so catastrophic that it would remove another firm from the capital markets.”

Competitive concerns loomed large over discussions about the fate of Big Four firm KPMG when it faced charges of selling illegal tax shelters. Ultimately the firm struck a deferred prosecution agreement that enabled it to escape the fate of Arthur Anderson.

In an address last week to the AICPA, SEC Chairman Christopher Cox acknowledged the lack of competition in the accounting field is a concern for regulators. “Investors have a significant stake in the development of a much more broad and competitive market for auditing services,” he said. “As regulators, we have a stake in seeing to it that our rules promote, rather than restrict, competition.”

PCAOB Delivers Enforcement Actions, Appoints New Chairman

The Public Company Accounting Oversight Board has de-registered two independent accountants and barred them from auditing public company financials in the future. The Board revoked registrations for Clyde B. Bailey of San Antonio, Texas, and Kwang Ho Lee of Los Angeles, and barred them from affiliating with any registered audit firm, citing their failure to follow PCAOB standards.

In Bailey’s case, the PCAOB took exception with his audit work associated with four separate small issuers. The Board said Bailey failed to get adequate evidence of management’s assertions in various areas, failed to flag departures from Generally Accepted Accounting Principles and violated other audit rules.

In Lee’s case, inspectors found a variety of accounting and auditing violations, including Lee’s acceptance of a board position with an audit client in violation of independence rules (see deregistration orders at right).

Gradison

In other Board business, the Securities and Exchange Commission has appointed board member Bill Gradison to serve as acting chairman following the Nov. 30 departure of William McDonough.

The SEC also outlined a procedure in will follow to name the permanent chairman and all future board members. The SEC was not clear, however, about how the new procedure will affect the status of board member Kayla Gillan, whose term expired in October but who continues to serve pending SEC action to reappoint or replace her.

The selection process includes procedures and timetables for recommending candidates, checking backgrounds, conducting interviews and making a final selection. “These new procedures are intended to make the selection process transparent, to encourage the thorough consideration of all qualified candidates, to ensure a thorough vetting of candidates, and to establish timetables for the expeditious appointment of individuals of the highest caliber for this critical body," said SEC Chairman Christopher Cox.

Gradison began with the board in October 2002 as a founding member.

Europe Looks For United States To Transition To IFRS

As U.S. regulators become more vocal in their call for reducing the complexity of Generally Accepted Accounting Principles and converging them with international standards (see related article at right), European regulators are hopeful the U.S. will abandon GAAP entirely and adopt International Financial Reporting Standards.

McCreevy

“It is my belief that accounting standards should be international and be used across the globe,” said Charlie McCreevy, European commissioner for internal market and services, in a recent address to a European accounting group. “We have committed to use IFRS, but other important markets—most notably the U.S.—have not done so.”

McCreevy said about 250 European Union issuers spend $1 million to $10 million (U.S. dollars) annually to reconcile their financial statements to U.S. GAAP for purposes of listing in U.S. markets. “But the story does not end here,” he said. “There are many companies from other jurisdictions who also have U.S. listings and use IFRS.”

In April, the SEC outlined its “roadmap” to eliminate reconciliation requirements for IFRS users by 2009. Julie A. Erhardt, deputy chief accountant for the SEC, said in an address to the American Institute of Certified Public Accountants last week that IFRS can “stand on their own two feet” in the U.S. markets when the SEC believes investors can understand and work with IFRS-based financial statements.

“This is possible if IFRS is a high-quality set of standards that is widely used and if the application of IFRS in practice is both faithful to the standards and consistent across entities,” she said. “Standing alone is precisely what the IFRS financial statements will need to do absent the U.S. GAAP reconciliation.”

Erhardt and McCreevy both said the continued convergence efforts of the Financial Accounting Standards Board and the International Accounting Standards Board will be key to ending reconciliation and creating truly international accounting standards.

“The more similar are the two sets of standards, the easier it is for investors to analyze and compare the resulting financial statements,” Erhardt said. “I believe investors could understand and work with these financial statements short of IFRS and U.S. GAAP being twins.”

U.S. Chamber To Study Capital Market Regulation

The U.S. Chamber of Commerce has formed a commission to study the impact of various federal and state regulations, including Sarbanes-Oxley, on U.S. capital markets, investors, and the economy as a whole.

Donahue

In a prepared statement, chamber President Thomas J. Donahue said the capital markets are overburdened by out-of-date regulations and a “confusing patchwork” of state and federal laws and regulations that need to be reviewed. “As our markets continue to evolve and change rapidly, we need to ensure that regulations stay current and prevent new economic risks while not stifling innovation and future investment,” he said.

The commission expects to issue a report in 2007 outlining specific legislative and regulatory recommendations that to strengthen markets, the Chamber said.